Financing Water Infrastructure

June 19, 2014

The United States needs to come up with a lot of money to maintain and repair water infrastructure. The estimated shortfall in funding is $20 billion a year for the next five years, says the American Society of Civil Engineers. States and the federal government are broke, and anti-tax sentiment is high. Is our infrastructure doomed to fail?

Engineers, environmentalists, and others who study infrastructure know the need is urgent. As is often the case when it comes to money, everyone thinks someone else should pony up. The utilities believe the federal government should kick in more, and the Environmental Protection Agency and other observers say the utilities don’t charge for the full cost of water service. The only thing everyone agrees on is that we need more money.

There are some innovative ways to raise funds. This paper will look at several that have been tried in different states or even abroad. Some will be more palatable than others, but it’s clear that we need to at least look at everything.

Who Pays?

Americans pay much less for water as a percent of gross domestic product than citizens in most other developed countries. “In general, we are underpaying for water,” says Rachel MacCleery, managing director of the Urban Land Institute’s Infrastructure Initiative. “Water rates don’t reflect scarcity in the west or the high cost of providing and maintaining water infrastructure in the east.” But she says it would be hard to raise them now because people are accustomed to low rates.

The great majority of funding for infrastructure comes from utility companies--about 95 percent, says the Water Infrastructure Network, which represents utilities. The rest comes from federal funds, often in EPA grants, and more recently in stimulus money.

The most likely source of financing for infrastructure is more and higher user fees, rather than general taxes that distort and hide costs from the public, says MacCleery. The first step is to get consumers to look at the fee as the cost of a service, not just another burdensome tax. That reframing might help people understand that the public will pay one way or other, through fees and taxes--no matter which combination of the financing methods below is used.

EPA’s Four Pillars

In a 2007 paper Tools for Financing Water Infrastructure, the EPA outlines its “Four Pillars” approach to promoting sustainable water infrastructure (see end of paper for complete reference). These tenets are important to be aware of given that EPA provides many grants to states for infrastructure.

Better management. EPA is working with utilities to draw on their best practices and share them throughout the industry, with an emphasis on cutting costs and investing in water systems using a risk-based approach.

Full-cost pricing. Charging for the full cost of building, operating and maintaining water systems is essential to sustainability (emphasis added).

Water efficiency. EPA is working with manufacturers, utilities, and others to set water efficiency levels for products and to promote water efficiency.

Watershed approaches. EPA emphasizes the importance of “making sound infrastructure and growth decisions within the context of how water flows through a watershed.” Watershed boundaries may not conform to state or municipal boundaries, so partnerships among federal, state, and local governments are essential.

Of course, applying these goals amid the competing priorities of a state or region is another matter. Below, we examine some financing alternatives.

Bonds

Bonds are the most common method for financing large water infrastructure projects. In 2009, utility bonds accounted for more than 12 percent of actively traded municipal bonds. They were both general obligation debt and revenue supported debt. Bonds are useful for financing capital infrastructure projects that will generate services and income for many years, as the money can be repaid over time. General obligation bonds can be repaid from any municipal source, including taxes. In some states, such as California, general obligation bonds must be approved by voters. Revenue bonds are repaid using the income paid by ratepayers (users of the water). One advantage to municipal and public utility bonds are typically tax-advantaged for, which allows the borrowing entity to pay lower rates to investors.

But a recent report says that increasing water scarcity in many parts of the country creates a hidden risk for investors in utility bonds. “Utilities rely on water to repay their bond debts,” says Mindy Lubber, president of Ceres, a national coalition of investors, environmental groups, and other public interest groups that produced the report that produced the report with Water Asset Management, a global equity investor in water related companies and assets. “If water supplies run short, utility revenues potentially fall, which means less money to pay off their bonds.” That scenario is a real possibility in water-stressed regions such as Los Angeles, Phoenix, Dallas, and Atlanta. Credit rating agencies, which don’t consistently take water supply problems into account, should use water risk stress tests when evaluating utility bond issuers, the report says.

State Revolving Funds

SRF programs provide loans for water projects at below market rate. Available in all 50 states, they are backed by state and federal funds. Many states multiply the money raised by issuing bonds backed by the SRF funds. One downside: The money is usually not sufficient to back a large capital project.
The California I-Bank (for Infrastructure and Economic Development Bank) has had a successful SRF since 1999, when it got a single state appropriation of $161 million. Over the years it has leveraged the one-time funding by making loans and issuing bonds based on loan repayments. It buys down the interest rate--recently, to just over 3 percent, versus the state rate of 4.5 to 5 percent. Even with the lower interest rate, the I-Bank has been able to use the original state appropriation and revenue from the bonds to offer $400 million in loans to municipalities for all types of infrastructure, says executive director Stan Hazelroth.

Of the total, 19 percent has gone to wastewater, 25 percent to drinking water, and 10 percent to drainage and flood control. Loan amounts range from $250,000 to $10 million, with terms of up to 30 years. One recent groundwater management project was approved in May 2010 for $5.4 million to the Borrego Water District, to design and build two new reservoirs and drill a new well to provide additional water capacity and storage to accommodate planned growth.

Regional Tax Sharing

The Minneapolis/St. Paul region has had a tax-sharing program that shares the cost of infrastructure and schools among seven counties since 1975. The less prosperous counties generally receive more money than they pay, but the region as a whole benefits from having updated infrastructure. Many other cities have studied the Twin Cities plan, in effect since 1975, but no other has used that model. The plan has had the added benefit of narrowing the disparities in regional business tax rates.

Alternative Rate Structures

Utilities can adjust water rates to encourage conservation. That saves money for the thrifty consumer, saves water for the community, and makes everyone aware that water is not a free or infinite resource.

After a drought in 1992, Seattle Public Utilities (SPU) was looking at new supply sources before realizing conservation would be cheaper. It started with a simple consumer awareness program, leaving kits with water-saving showerheads, toilet tank displacement inserts, and faucet aerators on the doorknobs of all homes in its service area. Subsequently, a new state plumbing code set efficiency standards requiring those items.

At the same time, SPU was changing its rate structure. First, it started charging higher rates in summer than winter for residential water use. (Seattle’s rainy season is in the winter. It can get quite dry in the summer, when water must be drawn from storage.) So as water rates increased rapidly over the next 10 years, most of the hikes were added to summer rates. The utility also instituted a system where residential charges are higher for any water used after the first 748 gallons.

For its part, SPU improved the efficiency of its system operations. Its own inspectors found the utility produced a large amount of water that wasn’t sold (“non-revenue water”), due to leaks in meters and reservoirs. Lining the reservoirs helped reduce leaks, and tightening the high-pressure washers used to clean the reservoirs eliminated wasteful overflow.

As a result of all these measures, Seattle’s water use dropped from 170 million gallons a day in 1990 to 120 this year, even as the population has increased, says SPU principal economist Bruce Flory. Per capita water use plunged 42 percent. Now, instead of needing a new water supply in a few years, SPU won’t need it until after 2060--an impressive outcome from conservation measures and incentivized rate-setting.

Public-Private Partnerships

Public-private partnerships have been tried with some transportation infrastructure projects (although not as much as in Europe, Canada, or Australia), but not with water. Utilities may use private contractors for operations and management, but that’s as close to partnership as they get. “People think of [water] as a government function, as a right,” says Maureen McAvey, executive vice president of the Urban Land Institute. “They also want some security, and they trust the government to keep [water] clean and safe.”

Nor is there much reason for the private sector to invest in water when rates are so low. Investors get more bang for their buck with toll roads or seaports. On the plus side for water, there is a built-in repayment scheme. Add partnership with private investors to the list of future possibilities.

Different Types of Local Taxes

Some communities tax property owners for drainage improvement districts. The tax amount, or even its existence, can vary depending on rainfall and likelihood of flooding. The tax can be used for flood control and other infrastructure projects. But in the current climate, any new tax is a tough sell.

Fees for Real Estate Practitioners to be Informed About

Sometimes municipalities use real estate charges, such as impact fees charged to developers, and effectively passed on to buyers, of new homes to help pay for infrastructure. In some communities, these fees can be thousands of dollars per home. Real estate practitioners need to be aware of them, and make sure their clients are fully informed.

Transaction-based fees or requirements are of particular concern to real estate agents and brokers, and they should be aware that the following two types of fees could be used for water infrastructure purposes:

Point-of-Sale Charges

Point-of-sale charges can be used to meet water infrastructure and conservation goals. A seller might, for instance, have to install water-saving fixtures in a home before it can be sold. However, such a requirement would add costs, reduce housing affordability, and potentially hinder real estate sales. And given the slow turnover of properties, it could take decades for a point-of-sale requirement to have an appreciable effect on water usage in a municipality.

Transfer Taxes

Transfer taxes, levied in more than 35 states, are paid by the buyer or seller or both, for general government expenditures. These can include infrastructure, although in many states, transfer tax revenue goes into the general fund rather than fund specific initiatives. (NAR policy is opposed to real estate transfer taxes.)